Brent oil not to go below $80; WTI could fall to $50

The international benchmark Brent crude has a ‘strong floor’ at $80 a barrel, as demand from emerging markets will soar, commodity strategists say

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Brent crude prices, which have averaged around $110 per barrel over the past few years, are unlikely to fall below $80 over the next two years; on the upside, they are capped at $140 for this year, going to $175 in 2017, according to a report by Bank of America Merrill Lynch commodity strategists.

Brent oil prices are unlikely to fall below $80 because production costs in the non-OPEC countries are increasing, the government budget breakeven levels for OPEC countries has been rising and, at such low prices, consumption would increase strongly, the strategists argue.

But “major demand destruction episodes” have happened when energy consumption reached 9% of gross domestic product in the past, and based on this the price of Brent is capped at $140 this year, increasing slowly to $175 in 2017.

Brent crude was trading at around $117 on Tuesday, on political uncertainty because of the upcoming elections in Italy and with traders looking for more data to see where the US economy was going.

West Texas Intermediate (WTI), the light sweet crude that is used as a benchmark for the oil market in North America, could be pushed down to $50 if rising availability of unconventional landlocked oil creates oversupply due to the inability of domestic refiners to soak up all the new volumes, the strategists said.

On Tuesday afternoon London time, WTI was trading at $95.6 a barrel, down 0.25% on the day.

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Bank of America Merrill Lynch’s strategists said that in some parts of the US Midwest soaring volumes and lack of transportation options left WTI oil trading at a $20 per barrel discount to Brent.

US refiners, who in the past invested in converting their plants to be able to process heavier crudes as at the time there were perceived shortages of light crudes, may not be able to fully displace crude imports, the strategists said.

“Thus, though not our base case, we continue to see risk that WTI could collapse to $50/bbl on an 18-24 month horizon,” they said.

EMERGING MARKETS DEMAND TO SOAR

Demand in developed markets is likely to remain sluggish but is expected to soar in emerging markets.

Heavily populated developing countries like China, India, Indonesia have very low passenger cars per capita ratios compared to advanced states like the US, Germany or Japan, “which implies huge potential for growth in their car fleet,” the strategists said.

In China, cars are getting bigger and more fuel intensive, with sales of SUVs particularly strong, while in India, despite projected cuts in fuel subsidies which are likely to hit oil consumption in the medium-term, income and urbanization levels are likely to rise strongly, meaning the country will “contribute positively to oil demand growth in the non-OECD Asia region over the next 5 years.”

The Middle East “has become one of the fastest-growing regions in terms of oil demand,” the report said, adding that oil demand growth in Saudi Arabia “rivals and often exceeds that of other EMs like India, Brazil and Russia.”

In Latin America, the outlook is also “remarkably robust,” as Brazil is building large-scale infrastructure ahead of hosting the World Cup in 2014 and the Olympic Games in 2016.

Last year, the Brazilian government launched big investment packages in rail, roads and ports, and announced airport privatizations.

“Needless to say, rapid expansion in roads is positive for oil consumption, as it increases the benefits of personal car ownership and incentivizes driving and car purchases,” the commodity strategists said.

An improving US economy and sharp increase in Chinese production costs supported the Mexican economy as well, where “oil demand growth continues unabated.”

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